$TSCO.L Tesco and the Buffett Test

I found this interesting PDF (http://is.gd/D93PHD) about Buffett’s purchase of Coca Cola from The Odd Lot blog (http://is.gd/6jGWEc).

The idea is disarmingly simple: you want at least a 10% earnings yield (not actually defined by Buffett, but the reasonable presumption is EBIT/EV), AND you want to convince yourself that that the “coupon” will grow. The sustainability of the coupon will likely depend on a few key factors, and it’s your job to identify and resolve them.

So let’s look at TSCO. According to Stockopedia, it has an EV of £30.75b, based on a share price of around 291p. Its Operating Profit reported on 16 April 2014 was 2631m. Taking that to be EBIT (and we can get into all sorts of arguments about how it needs to be adjusted), we get an earnings yield of 2631/30750 = 8.6%. This is below 10%. Could this be why Buffett was offloading some of it in late 2013?

TSCO’s mean operating income over the last 5 years was 3314m. That would give it an EY of 3314/30750 = 10.8%. So, arguably, it could be considered a purchase – although that depends on your view as to whether declines in profitability over the last two years is a permanent shift. Is it a price war that is only expected to be temporary, or are the likes of Aldi and Lidl changing the
landscape forever? Answers on a postcard, please.

Buffett increased his holding in TSCO on 13 Jan 2012, a day after TSCO announced its results, causing the share price to drop 19%. I’m not going to dig into filings, so let’s say that Buffett bought at 320p – probably close enough.

I’m being a bit broad-brushy, but let’s suppose Buffett was working with the latest available full year results at the time. So that would be annual fiscal data as of Feb 22 2014, with operating income of 3917m, net debt of 6790m and 8046m shares in issue. That gives me an EV = 6790 + 3.2*8046 = £32537m. Thus the EY is 3917/32537 = 12.0%.

So perhaps we should not have been surprised at Buffett topping up on TSCO at the time he did. His crystal ball seems to have gotten a bit hazier since then.

Happy investing to you all.

Update 04-Jul-2014 I have been reading around, and it seems that Buffett wants 10% in pre-tax earnings. So we want to look at things from an equity basis, rather than a firm basis. This actually makes our calculations easier. The latest reported income before tax was 2259m. The market cap is 23050m, based on a share price of 290.85p. So the pretax earnings yield is 2259/23050 = 9.8%. This is below a buy threshold, although only just.


About mcturra2000

Computer programmer living in Scotland.
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